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We investigate how firms’ responses to misconduct change when the institutional environment becomes more stringent. Organizational theory offers conflicting perspectives on whether new legislation will increase or decrease pressure on firms to take remedial action following misconduct. The dominant perspective posits that new legislation increases expectations of firm behavior, amplifying pressure on them to take remedial action after misconduct. A more recent perspective, however, suggests that the mere necessity to meet more stringent regulatory requirements certifies firms as legitimate to relevant audiences. This certification effect buffers firms, reducing the pressure for them to take remedial action after misconduct. Using a temporary, largely arbitrary exemption from a key provision of the Sarbanes-Oxley Act, we show that firms that were not required to meet all the regulatory standards of good governance it required became 45% more likely to replace their CEOs following the announcement of an earnings restatement after Sarbanes-Oxley. On the other hand, those that were required to meet all of Sarbanes-Oxley’s provisions became 26% less likely to replace their CEOs following a restatement announcement. Ironically, CEOs at firms with a legislative mandate intended to increase accountability for corporate misconduct shoulder less blame than do CEOs at firms without such legislative demands.

This chapter explores the advantages (for large investors) of directly owning productive assets, compared with indirect ownership through stock in corporations. Significant factors are agency costs and recent changes in the tax and regulatory environment. Recent corporate scandals have led to legislative and regulatory responses that significantly increase the monitoring costs and other burdens of becoming or remaining a public corporation. As a result, there has been a substantial increase in going-private transactions, particularly among smaller public companies. Acquisitions and minority equity positions that allow large corporations to join with smaller companies have also increased. The pressures to go private are not entirely new, however. This chapter, reflecting collaboration by professors of finance and business law, traces the legal concept that the corporation is an entity separate and apart from its owners, showing how the legal status of corporations hinders resolution of conflicts among the parties to the enterprise. Thus, there have long been fundamental flaws inherent in the corporation as the form of organization for certain activities. The current wave of Sarbanes–Oxley restructuring via private equity firms is part of a significant increase in direct ownership of major assets by institutional investors. Direct ownership prevents management expropriation of resources, and is preferable to corporate ownership whenever other alternatives for indemnification or liability limitation are available (such as insurance, limited partnerships, limited liability companies, etc.). Finally, the renewal of direct ownership is not a radical shift, but a return to long-established tradition in the organization of business activities.

The manner in which publicly traded companies’ management teams handle their firm’s free cash flows (FCF) has been an issue for many decades, because it is difficult to determine whether these management teams work for their own benefit or for that of their shareholders. Recent financial scandals have heightened mistrust of management. This mistrust, in turn, may have increased the pressure to reduce the portion of FCF left under management’s control. Boards of directors control dividend payout decisions, thus determining the portion of FCF available to corporate management. This paper examines whether the 2002 legal response to corporate financial reporting scandals, which came in the form of many new initiatives and requirements imposed by the Sarbanes–Oxley Act of 2002 (SOX) on all publicly traded firms, was relevant to dividend payouts. This question is investigated by noting that the impact of these new requirements differed among firms. Some firms had already introduced the use of independent directors and fully independent committees prior to SOX making them compulsory in 2002. This paper examines whether these “pre-adopters” experienced less change in their dividend payout policies than those firms that were forced to change the composition of their board and committees.

This investigation examines the effect on dividend payouts for listed firms attributable to the SOX and concurrent changes in stock exchange regulations that compelled increased use of independent directors and fully independent committees. To study the impact of SOX and the associated, required, changes in the composition of boards of directors for many firms, the difference-in-differences methodology is employed to overcome the endogeneity concerns that have consistently challenged prior governance studies. This was accomplished by examining the effects on dividend payouts associated with the exogenously forced addition of independent directors to the boards of publicly listed firms. The results reveal that there is a significant positive relationship between firms that were compelled by law to change their boards and increases in average changes in dividend payouts and percentage changes in dividends paid, when compared to firms that had pre-adopted the Sarbanes–Oxley corporate board composition requirements. A further exploratory analysis showed that the same significant positive relationship is detected for increases in average changes in total dollars distributed, where stock repurchase dollars are combined with dividend payouts. These findings imply that these board composition changes led to decisions that increased dividend payouts in percentage terms, as well as dividend payouts and total dollars distributed in aggregate dollar amount terms.

This chapter provides evidence that legislation affecting litigation risk has an influence on the financial reporting behavior of corporate management, we address the following research questions: (1) Do firms react to changes in litigation risk that result from the passage of new legislation at the federal level by adjusting their level of conservatism with regard to reporting earnings? (2) How do firms’ levels of conservatism react to changes in litigation risk over time? We analyze the level and trend in conditional conservatism to evaluate the efficacy of legislation in altering managerial reporting choice. Our examination takes place in the context of two distinct pieces of legislation intended to alter the legal environment faced by corporate managers: (1) the PSLRA (1995), and (2) Sarbanes–Oxley Act of 2002. Our findings indicate that the passage of legislation that increases litigation risk is associated with increased timeliness (conservatism) in financial reporting by managers. The increased timeliness, however, begins to subside shortly after the initial effect. While the initial effect of a reduction in litigation risk is negligible, subsequent periods exhibit declining timeliness (conservatism) in financial reporting. Our results indicate that legislative actions can be successful in altering management reporting choice through changes in legal regime. However, our results also demonstrate that the desired influence of these legislative policies may be transient.

Mandatory auditor firm rotation (mandatory rotation) has been a controversial issue in the United States for many decades. Mandatory rotation has been considered at various times as a means of improving auditor independence. For example, in the United States, the Public Company Accounting Oversight Board (PCAOB) has considered mandatory rotation as a solution to the independence problem (PCAOB, 2011) and the European Parliament approved legislation that will require mandatory rotation in the near future (Council of European Union, 2014). The concept of implementing a mandatory rotation policy has been encouraged by some constituents of audited financial statements and rejected by other constituents of audited financial statements. Although there are apparent pros and cons of such a policy, the developmental process of such a policy in this country has not necessarily been an open-democratic, objective process. Universal mandatory rotation may or may not be the ideal solution; however, an open-democratic, objective process is needed to facilitate the development of a solution that considers the needs of all major stakeholders of audited financial statements – not simply accounting firms and public companies, but also investors. The purpose of this paper is to critically examine key issues relating to mandatory rotation and to encourage and stimulate future research and ongoing dialogue regarding this issue, in spite of efforts by certain constituents to silence the issue. This paper provides an overview of the various reasons, including practical, theoretical, political, and self-motivated reasons, why a mandatory rotation policy has not been implemented in the United States in order to address the potential conflict of interest between the auditor and client. This paper will also discuss how some deliberations of mandatory rotation have been flawed. The paper concludes with a summary of key issues along with two approaches for regulators, policy makers, and academics to consider as ways to improve the process and address auditor independence. The authors are not advocating for any specific solution; however, we are advocating for a more objective, unified approach and for the dialogue regarding auditor rotation to continue.

This paper aims to help auditors manage the risk of Foreign Corrupt Practices Act (“FCPA”) violations of the companies that they audit, particularly those with operations in Latin America.

First, the paper describes the relevant provisions of the FCPA. Second, it identifies the common schemes and transactions associated with heightened risk of FCPA liability in Latin America and provides recommendations to minimize this risk. Third, it discusses the responsibilities of auditors under U.S. securities laws and regulations with respect to the FCPA violations of their clients. Finally, it describes the sanctions that auditors could face if they fail to fulfill their responsibilities regarding these FCPA violations. The paper is based on data collected from various documents including laws, cases, accounting and auditing standards, litigation releases, press releases, deferred prosecution agreements, and enforcement actions.

Auditors have a responsibility under Section 10A(a) of the Exchange Act to design procedures that provide reasonable assurances of detecting the FCPA violations of their clients, which are illegal acts with direct and material effects on the financial statements. In addition, auditors have a responsibility under Section 10A(b) of the Exchange Act to report the violations of the FCPA that they detect during the audit to the appropriate level of management. If management does not take the necessary remedial steps, auditors must report FCPA violations to the U.S. Securities and Exchange Commission. In order to reduce their FCPA-related liability and fulfill their responsibilities under U.S. securities laws and accounting standards, auditors should closely scrutinize transactions with a high risk of FCPA liability. An analysis of FCPA cases occurring in Latin America reveals six categories of transactions with heightened FCPA risk.

While there is much literature regarding a company’s compliance with the FCPA, there has not been much literature about the auditor’s responsibilities with respect to the FCPA violations of their clients. This paper attempts to start bridging this gap by providing guidance to auditors regarding their responsibilities to detect and report FCPA violations.

Given the conflicting attitudes that people have toward those who report wrongdoing and a lack of empirical research specifically examining subsequent hiring, it is an open question as to whether accounting professionals would want to work with former whistleblowers. The authors examine this question using an experimental design, in which participants evaluate an employment candidate before and after the person discloses having been a whistleblower. Four manipulations of whistleblowing are used in both a within-subjects and a between-subjects manipulation. The authors’ results demonstrate that accounting professionals’ intentions to recommend a candidate for hire decrease after they are informed that a strong candidate has a whistleblowing past. A candidate is viewed most negatively, however, when discovering malfeasance and electing not to blow the whistle internally. Moreover, when the whistle is blown internally and the superior takes no action, the candidate who remained silent and chose not to continue to push the issue is viewed more negatively than the candidate who proceeded to blow the whistle externally. Although a candidate having a whistleblowing past appears to pose a cautionary signal in the interview process, participants reacted more harshly when the candidate failed to act or lacked the durable moral courage to see the matter through to completion.

This paper explores the advantages (for large investors) of directly owning productive assets, compared with indirect ownership through stock in corporations. Significant factors are agency costs and recent changes in the tax and regulatory environment. Recent corporate scandals have led to legislative and regulatory responses that significantly increase the monitoring costs and other burdens of becoming or remaining a public corporation. As a result, there has been a substantial increase in going-private transactions, particularly among smaller public companies. However, the pressures to go private are not entirely new. We trace the legal concept that the corporation is an entity separate and apart from its owners, showing how the legal status of corporations hinders resolution of conflicts among the parties to the enterprise. Thus, there have long been fundamental flaws inherent in the corporation as the form of organization for certain activities. Direct ownership of major assets by investors prevents future expropriation of resources, and is preferable to corporate ownership whenever other alternatives for indemnification or liability limitation are available (such as insurance, limited partnerships, limited liability companies, etc.). Finally, the renewal of direct ownership is not a radical shift, but a return to long-established tradition in the organization of business activities.